Tag Archives: Debt

Lessons from a Masters In Business Administration: Juicing Up The Returns

Juicing Up The Returns: Imagine 2 companies, each has assets worth $1,000,000. The first has funded its assets with $800,000 in borrowed money and $200,000 in equity from investors. The interest rate is 10% on borrowed money and the tax is 50%. Each year the $1,000,000 worth of assets leads to $200,000 in operating profits. $80,000 goes to pay interest on the debt, which the government calls an expense, of the $120,000, $60,000 pays taxes and the remaining $60,000 goes to equity holders. For their $200,000, the equity holder get a 30% return annually. Now imagine the same company funded with equity alone. They produce the same $200,000 in operating profits. There is no interest payment. $100,000 goes to government in taxes, leaving the equity holders with $100,000 which is a 10% return.

So, which would you want a Juiced or not juiced company?

Next you might buy a non-juice (debt-free) company, and dump your debt incurred into that new company. If at all possible, this will equal or exceed the amount of cash you yourself put into the deal. So you then are able to recoup your investment. Pooling debt into a company carries the innocuous term “leveraging the balance sheet.”

Now, you need to generate cash to keep up those interest payments. The company will be better run because it needs to run well or die, and it can be sold two or three years down the line at a huge profit:

First, you must strip the HQ down to its bare essentials, removing any perks or visible signs of comfort. Gut the health plans, fire loyal employees to keep up with crushing interest payments. Then you get consultants who are sharp-suited number crushers booked into the local Four Seasons, who tell you to keep squeezing the company, and the people within it. If you do so, you will be rewarded handsomely. Management is loyal to its equity holders, even though they plan to drop the business within a few years. Then the consultants send you a bill for their services which states is so high that you will have to take on more debt. After all, the government pays a chunk of it to charge interest as an expense. This enhances the returns of equity.

Next, you float the company on the stock exchange as if it has been ‘improved.’ The private equity investor recouped his original investment months ago by selling their stocks off in the IPOs very young stages. If the investor bought it for $1 billion and can sell it for $3 billion, the $2 billion is all his + the original equity. There will be a lot of suckers at the end of that ride!

This behaviour can potentially victimize communities where hedge funds are in it for the money, and see companies as economic machines. The social role of a company is zero. A private equity investor can stay in his lavish apartment, and trust that everything will be right without having to deal with the day to day consequences of their actions.

So some important questions need to be asked: Where are the leaders and difference-makers in private equity? What conscience do they bring to their work? What balance do they see in their roles as economic and social actors?

[This is a synopsis of several books on the MBA experience including What They Teach You At Harvard Business School by P.D. Broughton]

Lessons from a Masters In Business Administration: Negotiations 101, Leverage and Debt Theory

Negotiations 101: the fundamentals begin with discussing ethics followed by the basic analytical tools of negotiations. The negotiator often tries to misled his opponent but the risk of unethical negotiations is a bad reputation. Bluffing is fine in negotiations. The sophistication of the parties is also relevant. Selling a complicated derivative to an economic illiterate and then blaming that person for not understanding the contracts hurts you in court proceeding.

There are three schools of negotiators: (1) the poker player who regards it all as a game; (2) the idealist who insists on doing the right thing every time; and (3) the pragmatist, who knows that what goes around comes around. BATNA is the ‘best alternative to a negotiated agreement’. BATNA prevents you from making a bad deal by asking what the alternatives might be; in other words you have a walk away strategy. ZOPA is the zone of possible agreement which means the general area/scope of agreement possible. When you go into a negotiation, you should determine the other person’s position a priori. The gifted negotiator adopts a three-dimensional perspective, working both at the table and away from it. If negotiations stall, the negotiator should go to the balcony to gain perspective and reframe the issues, moving from defensive positioning to shared interests.

Leverage and Debt Theory: hedge funds and private equity are awash with money. So much so that investment banking is considered a second tier move. Surely running a company is more important than banking services? Private equity brings managers, and owners closer together. In Private Equity and Hedge Funds, the money comes courtesy of debt. Debt is actually not a bad thing, because it allows you to leverage, structure your financial deal etc. Things become more possible using this method. Debt focuses the mind, forcing people to concentrate on THE ONLY THING THAT MATTERS: the cash flowing out of the business. Debt for lack of a better word, is good. Debt works. If a company is struggling to be valuable, then you would simply load up the balance sheet with debt. More to come.

[This is a synopsis of several books on the MBA experience including What They Teach You At Harvard Business School by P.D. Broughton]

USA Inc Criticism

  • I like the infographics.
  • Stating that you are “non-partisan” is hard to believe. She really means that she will take a centrist or independent position as opposed to the extreme partisanship that characterizes US politics? Everyone has a set of experiences that informs their understanding.
  • Mary Meeker, a Venture Capitalist, is concerned about a new business plan for the USA, so she is extrapolating business and family finance into government. This is a common analogy to simplify a complicated entity like the US Federal Government.
  • I don’t think balanced-budgets is a silver bullet solution to America’s whoas. Debt is about loaning out for investment, spending forward. What has changed is that the US is less confident about its future. Like the UK in the 1950s onward, there is this sense of a managed decline.
  • There are more fundamental problems with the US that aren’t related to the size of the US debt, like it’s trade in balance with China, it’s penchant to assist Morgan Stanley and other investment banks to behave without moral hazard, it’s service-based bubble economy, it’s mediocre manufacturing, it’s expensive wars in Iraq and Afghanistan, it’s aging population that are living longer and producing less value. Get them back to work?
  • If the debt to GDP ratio was such a problem then why didn’t the US have a financial crisis in the mid 1990s when debt to GDP was already bad enough? Japan has a huge debt to GDP and it’s been cruising along for a decade plus since it’s financial crisis. The debt is not the core fiscal problem in the US.
  • Spending beyond ones means as individuals or as companies is very bad, but a country is not analogous because that simply gets passed forward.

Problem: Raising Taxes Hurts Mary Meeker therefore She Opposes Any Tax Hikes.

  • If government were a business then it should surely increase revenue in the short-term by either cutting costs or raising prices. An obvious area for creating short-term revenue is through price discrimination against affluent customers.  These high tax payers have limited substitution possibilities i.e. they are unlikely to leave the US so increasing prices is wise for USA Inc. Of course, anyone in business knows that it is easier to cut costs (in the funnel) then increase prices (at the top of the funnel).
  • Why doesn’t she advocate tax hikes? Of course, higher taxes for the highest income earners harms her interest group and she can argue that higher taxes “lead to slower growth, less consumer spending” with less room to innovate and invest. Many democrats do not believe this is actually true. Most universities are filled with academics who say that “trickle down does not work.”
  • Increasing taxes will increase the power and size of the USA Inc to actually address the debt issue she is worried about. That solution doesn’t work for her because she wants to reduce the size of government, and restrict its influence. She never mentions the financial sector’s economic crisis but focuses a lot on government spending being too high for long-term obligations to Medicare and Medicaid and other “Entitlements.”
  • For Meeker, entitlements = waste. The very term Entitlement is a conservative spin on social spending. It implies that those who receive entitlements are literally entitled to being given money while being lazy. While some if not most are seniors, disabled or soliders.
  • Government is not analogous to a business. It’s an oversimplification to meet a value-laden hypothesis about what a prosperous country requires. Debt is an important part of investing in the USA’s future growth.

Conclusion: Meeker’s Hypothesis was probably exactly what her conclusions were. All the data was used to clarify what she wanted to believe in the first place. Notice that her recommendations do not effect her or her friends in any substantial way.

  • Babyboomers, Medicare, and Medicaid are the problem.
  • “The War in Iraq wasn’t even that big of deal compared to percentage of GDP”….except for the fact that it didn’t need to occur at all, and many of the costs are not measured by her metrics!
  • There has been a lot of evidence that the babyboomer retirement is not going to happen the way they would like. And we can’t afford to take care of the babyboomers, that’s agreed. But USA Inc cannot pull a GM restructuring.
  • Debt isn’t such a big deal. This is only a problem now that the economy is stagnant and the jobs of the future have actually been too efficient and have cut out people from making money.
  • Meekers is not willing to harm anyone that she values: 1) Private healthcare, 2) billionaires taxation, 3) financial institutions
  • Meekers is willing to harm anyone that is not of value to her: 1) Spending cuts on “Entitlements”, 2) Cuts to social programs for the least well off, 3) Extending retirement age since she loves her work and will likely die working at her VC fund.
  • It’s all very complicated, laden with value judgements. I think the US needs ambitious new goals!

Stephen Lewis on Development & Short-Term Leaders

Official Development Assistance

Lewis advocates the ODA. The ODA is sourced from the G8 nations. Tony Blair called for 0.7% of GDP by the G8. Lester B. Pearson set the benchmark of 0.7% of GDP for foreign aid. Few countries have come close to that number, unfortunately. Scandinavian countries are the only countries to go beyond 0.7% GDP. The US and Japan do not come close to fulfilling the basic benchmark. Italy is unreliable. UK and France promise to meet the benchmark by 2012. Japan wanted a seat on the Security Council and needed support of the African countries at the G8. SO, Japan made a promise to double its support from their previous numbers, unfortunately Japan doesn’t contribute much at all. The US only gives 3 Billion dollar per year. Bush might double that funding.

Political Short-Term Leadership

Paul Martin will only be around for a while. Bush won’t be around in 2010. Blair will be gone as well. Most G8 leaders in 2005 will be out to pasture. Martin propounds the vitues of the policy but doesn’t achieve the goal. The responsibility will be for the next set of leaders. Promises that are not kept internationally are a serious moral failure. Lewis has not faith in the political leadership.